Platt Perspective on Business and Technology

Facebook and the challenge of initial public offerings and fair market valuation

Posted in in the News, macroeconomics, startups by Timothy Platt on July 16, 2012

I write this posting with the recent Facebook initial public offering (IPO) in mind. And in many respects I write this as if a continuation of my recent series on the cost-benefits analysis of economic regulatory rules (see Macroeconomics and Business, posting 64 and loosely following.)

Facebook rode into its IPO on a tidal wave of hype. Seemingly everyone was talking about Mark Zuckerberg and of his company, Facebook as the up and coming $100 billion wonder, and the investment to buy in on for 2012 and beyond. And the Facebook IPO came in as one of the biggest public launches in history with an initial overall valuation showing at just over $104 billion dollars. And over the coming weeks the value of Facebook’s new publically traded stock shares fell, and with losses that at times brought the overall valuation of the company down to less than 80% of the initial market capitalization as reached at the end of the first day of public trading.

Depending on who was doing the analysis, Facebook’s initial price-earnings ratio (P/E ratio) ranged from a very large 85 and up to as much as 100 and more so according to the fundamentals, this company was tremendously overvalued. But Facebook’s key underwriters, Morgan Stanley, JP Morgan and Goldman Sachs were pushing this as if it were the best investment opportunity in existence. And then as the price of Facebook shares failed to rise, and in fact as it fell, news reports started to surface suggesting that these companies were publically taking one position as to the value of Facebook and its growth potential, while privately and in internal documents concluding something very different.

Facebook’s IPO was plagued with technical problems on its day one with initial trading delayed on the NASDAQ exchange by a half hour and with problems continuing in making and completing trades – some investors and would-be investors did not even know if their trades had gone through. More than 40 law suits were filed against Facebook in the first month after that IPO launch, and the US Securities and Exchange Commission and other regulatory agencies began investigations. There were allegations that this IPO was developed as if a pump and dump scheme – a fraudulent practice usually associated with microcap stocks in which prices are artificially inflated through false and misleading statements, in preparation for dumping shares for an immediate inflated profit.

The reputations of both Morgan Stanley, the primary IPO underwriter, and of the NASDAQ were damaged by this offering and how it was mismanaged. Morgan Stanley, I add, did very well out of this making a substantial profit from the IPO and from sale of Facebook shares.

One aspect of the fallout coming from this series of events has been the casting of a pall over social media and new technology IPO’s in general.

My goal in this posting is not to make a statement as to the validity of this IPO and how it was set up and carried out. And I am not writing this in commentary as to the validity of any claims, for or against Facebook, or Morgan Stanley or the NASDAQ or others, or with regard to any regulatory investigations anticipated, planned or underway.

My reason for offering a brief and I admit selective accounting of this IPO is to discuss

• The issues of transparency and openness that this story reveals, and the need for them
• And how many if not most of the problems that developed here stemmed from a failure in that – and with the uneven playing field that different classes of investors faced when making their investment decisions.

Hype was real and in retrospect tremendously overblown, and that was fed by insider “news” and insight. Reality could not live up to overblown expectations, and while some made tremendous profits, others lost that value from their investments in this new stock offering.

And I come back to the basic regulatory approach that I developed and discussed in my series: Considering a Cost-Benefits Analysis of Economic Regulatory Rules as cited above at the start of this posting.

• The absolute levels of potential risk and benefit are not as important as the symmetrical distribution of risk and benefit shared – equally at least ideally, by all involved stakeholders.
• The real risk of instability and crisis comes from risk and benefits distribution asymmetry.
• And I add here that asymmetry developed and this IPO ran into trouble because of systematic failures in the sharing of crucial information with all investors, potential investors and investor classes and groups, as individuals and organizations made their investment decisions regarding this IPO and followed through upon them. Failed communication and misinformation prevailed and with combined losses for those who were not insiders, totaling well into the billions of dollars.

This is a story I have been thinking about and following, and it is one that I might very well return to and both for Facebook and its IPO and with regard to IPO’s in general. Meanwhile, you can find this and related postings at Macroeconomics and Business and I have also included this in Startups and Early Stage Businesses.

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